Fed Said to Seek Oversight of Credit-Default Swap Clearinghouse
By Matthew Leising
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Nov. 12 (Bloomberg) -- The Federal Reserve is seeking to become the lead regulator for clearing trades in the $33 trillion credit-default swap market, according to people with knowledge of the proposal.
The Fed, the U.S. Securities and Exchange Commission, the Treasury Department and the Commodity Futures Trading Commission are discussing a memorandum of understanding that lays out oversight of clearinghouses that would become the central counterparty to credit-default swap trades, said the people who asked not to be named because the discussions are private.
``The Fed is the natural place for it to go,'' said Craig Pirrong, a finance professor who studies futures markets at the University of Houston. ``The main concern is systemic risk,'' Pirrong said, which the Fed is better equipped to control.
The Fed has been pushing the industry to form a clearinghouse that would absorb losses should a market maker fail. Regulators stepped up their efforts after the failure of Lehman Brothers Holdings Inc. in September and the near-collapse of American International Group Inc. The New York Fed has been meeting with groups including CME Group Inc., Intercontinental Exchange Inc. and NYSE Euronext to press them to accelerate their progress.
New York Fed spokesman Andrew Williams declined to comment, as did CFTC spokesman David Gary and the SEC's John Nester. Treasury spokeswoman Michele Davis didn't immediately respond to requests for comment.
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The SEC and CFTC would also share trading information under the plan, the people said.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They were conceived to protect bondholders against default, and pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.
An announcement of the regulatory structure could come by the end of the week when President George W. Bush hosts a gathering of world leaders in Washington to discuss ways to fix the financial crisis, said one of the people who has read a draft of the plan.
``All the regulators want to push this forward,'' Pirrong said. ``The credit crisis meeting on Friday is as good an excuse as any.''
Chicago-based CME Group is competing with Intercontinental Exchange of Atlanta and NYSE Euronext to create a system. CME Group Chief Executive Officer Craig Donohue said last week that he is open to Fed oversight for his clearing plan. CME Group is currently regulated by the CFTC.
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Intercontinental Exchange Chief Executive Officer Jeff Sprecher has set up his clearing plan as a special purpose banking entity within the state of New York. Intercontinental agreed to buy Chicago-based Clearing Corp. last week to help it get participation in its plan from the nine major banks that own the Clearing Corp. and that make up the majority of the market.
CME Group, partnered with hedge fund Citadel Investment Group LLC, has said it is ready to begin clearing CDS contracts as soon as it receives regulatory approval. Sprecher said today his group may be ready before year end.
``We're waiting for regulatory approval. I think positions will start moving in the next few weeks,'' he said at the Futures Industry Association conference in Chicago today.
To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net.
Last Updated: November 12, 2008 00:01 EST
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